Author: Logan Snyder

China & Taiwan

Taiwan recently elected Lai Ching-te, a staunch pro-democracy candidate, as president. In response to the election, China’s State Council Taiwan Affairs Office stated, “Taiwan independence” and peace across the Taiwan Strait cannot coexist, as the former is also incompatible with the interests and welfare of Taiwan compatriots.”

Taiwan produces around 90% of the world’s leading-edge semiconductors. Bloomberg Economics pegged the cost of a Taiwan War at around $10 trillion or about 10% of global GDP!
Recently I was speaking with a technology analyst about Taiwan Semiconductor (TSM) and asked him his opinion- His answer was that from a technology standpoint, if Taiwan Semi’s fabs were destroyed, it could set back humanity 10-15 years!

Escalating tensions in the South China Sea are a primary geopolitical risk in 2024.

Russia-Ukraine War

As the stalemate drags on, it seems like we’re slowly gravitating towards negotiated peace. Still, the risk remains that this conflict escalates in some unforeseen way. Could it bring about Putin’s downfall and invite chaos? Could other countries join the fray?

When this war first broke out, we saw how important Ukraine and Russia are for global supply chains as commodity prices spiked dramatically. The economy adjusted but today’s status-quo is not guaranteed.

This war is no longer headline news but the risk of escalation remains.

Israel & Gaza Ramifications

Directly, the Israeli/Hamas conflict is insignificant to global GDP and global financial markets. Indirectly, a conflict in the turbulent Middle East represents a meaningful geopolitical risk.

For example, Yemen’s Houthi rebels began launching rockets at any ship bound for Israel. Now they’re simply attacking any ships they can reach in one of the busiest shipping lanes in the world. In response, shipping companies are avoiding the area but this is adding days on to voyage times and putting upward pressure on shipping rates (below).

As a follow-on to the turbulence in Israel, Iran is trying to take advantage of the void and to assert itself as a regional hegemon.

Iran recently launched missiles into Iraq and Syria claiming to strike Israeli intelligence bases. Days later, Iran also provoked its neighbor and fellow nuclear power Pakistan by launching a strike on Pakistani soil.

Ongoing or escalating turbulence in the Middle East is the primary geopolitical risk in the year ahead.

US Foreign Policy

Neoconservative foreign policy culminated in the failures in Iraq and Afghanistan. The result was an overcorrection towards an “America First” style of foreign policy.

As the US takes a less active role around the globe, it presents an opportunity for regional players to exert more influence (like Iran).

The further the US steps back, the higher the risk that a geopolitical event escalates and becomes an issue for investors.

What Didn’t Make the List? (But is Still Making Headlines)

Artificial Intelligence

Eventually, but not in 2024.

Venezuela/Guyana

Venezuela reignited a century-old border dispute with Guyana, seeking to claim more than half of Guyana as Venezuelan territory. Recent oil production for the offshore Stabroek field might have something to do with it.

Why won’t it escalate?

Venezuela can’t even produce the oil reserves that they do have. Perhaps a territorial dispute helps dictator Nicolas Maduro cling to power.

The US and UK have already voiced their opposition to Venezuela taking the land. The US sent defense officials and the UK sent the a warship to Guyana.

No one is helping Venezuela. Even the Chinese want Guyana to remain independent and stable. The Stabroek field is owned by Exxon (45%), Chevron (30%), and the Chinese National Offshore Oil Corp. (CNOOC) (25%).

First, he identifies four major tailwinds to recent performance:

1. Rates went from high to low.
2. Monetary policy printed massive amounts of money.
3. Economies borrowed against future demand via fiscal stimulus and borrowing.
4. Globalization improved efficiencies.

“It does not surprise me with those four tailwinds that risk assets (equities growth, real estate, things like that) did really well. But I ask myself, are any of those four things true today?”

“Looking backward is not likely to be a good indication of what needs to be done going forward for investing success.”

“In 2008, we came very close to an absolute debacle in our financial system. And the rules of how our financial markets work were fundamentally rewritten. We, not just Apollo, but all of us, we just didn’t notice, because right after we changed the rules we printed $8 trillion and everything went up and to the right. Well now that we are no longer doing that, now that rates are up, now that there are headwinds, we are starting to notice some of these changes.”

1. Change #1: Less Public Market Liquidity
   1. By some estimates, dealer capital (which facilitates trading) is roughly 10% today what it was in 2008, yet markets are 3x their size.
   2. Liquidity might exist on the way up, but not the way down, contributing to greater volatility.
2. Change #2: De-Banking
   1. Dodd-Frank constrained banks. The failures of SVB, First Republic, and Credit Suisse will spur more regulation and further this de-banking.
   2. As banks retreat, other providers of liquidity and capital will fill the void. This includes alternatives such as private credit.
3. Change #3: Indexation and Correlation
   1. “80% of the volume traded today is the S&P 500, 60% of our markets are ETFs.”
   2. “10 stocks make up nearly 35% of the S&P 500 and these 10 stocks are responsible for 100% of year-to-date returns. These 10 stocks have traded between 52x and 44x P/E over the last few weeks. Not many of you come in every day looking to buy 50 P/E stocks. Yet we feel really comfortable with a massive portion of our country’s retirement system assets and fiduciary assets in 50 P/E stocks.”

“We had this perception historically that public was safe and private was risky. I ask, is that even the right framework to think about how market structure is today?”

As Marc points out, public markets are losing some of their ‘edge’ over private markets.

Going forward, alternatives will play a larger role, not just in client portfolios, but in the entire economy. As this develops, many financial firms will rush to exploit this opportunity- most of them will make (dumb) mistakes.

The best positioned firms are those like Cobblestone, who spent the last decade laying the groundwork and building up institutional knowledge.

Housing is the most significant issue facing the world’s second biggest economy.

The difference now is that the government has started taking steps to address the issue.

So far, China’s policy changes have been incremental in nature- a far-cry from the full-throttle “bazooka” caliber stimulus many have called for.

So far, China’s measures include:

• Cutting interest rates and providing liquidity to help developers complete stalled housing projects.
• Pressuring banks to lower rates and extend credit to developers.
• Trying to support economic growth through other avenues like infrastructure spending.

Is this enough? No. 

Is this just the beginning of a larger policy response? Perhaps.

Bulls say:

+ This is just the start of stimulus. When China wants something done, it gets done.

+ Government stimulus programs have worked before.

+ Stocks only go up.

Bears say:

– This is not the 08/09 housing crisis- it’s actually much worse.

– China’s housing issues are structure, not cyclical.

– You can stabilize housing but China’s population is not growing. Housing will NOT be a driver of economic growth going forward.

– You can save the developers and finish the apartments but the “animal spirits” of the Chinese property market are gone (see: Japan in 1992).

Some Key Problems:

• The extent of China’s housing crisis is difficult to grasp. China’s property sector is notoriously opaque with liabilities running through companies, banks, shadow banks, and local governments.
• Dysfunctional Funding Model. Chinese developers fund their activity by pre-selling unfinished apartments. Unfinished apartment towers represent buyers’ hard-earned savings. It’s not surprising that consumer sentiment, particularly towards property purchases, is extremely low.
  • Is China’s pre-sale funding model sustainable? Probably not. In other countries, buyers have protections like escrow accounts and installment accounts to protect against what’s happening in China.
• China can’t grow into its excess housing. China’s population is shrinking. There is no immigration to offset this.

Government stimulus is one heck of a tool, but it can’t fix every problem. China has some very severe imbalances at the root of its housing crisis- it isn’t clear to me how government policy can easily address these.

I remain highly skeptical that China’s economy can return to the high-single-digit GDP growth it once enjoyed.

For example, here’s Chairman Powell in his press conference on November 1st: “the way our policy works is, and sometimes it works with lags of course, which can be long and variable, but ultimately, if you raise the interest rate, you do see those effects.”

Perhaps the most impactful surprise of 2023 was the relentless strength of the US consumer. We’ve been actively following consumer’s relentless strength since September 2022 but now we’re seeing some cracks emerging.

We’re not calling for a major crash, but the consumer is starting to feel the long and variable impacts of monetary policy.

Employment Market Strong but Softening

• Employment is THE most important variable for consumption. People spend money when they have jobs. We are watching employment trends extremely closely. 
• After peaking in 2022, job openings are trending downward.
• Will businesses continue hiring?
  • When rates were low, many businesses issued debt at low interest rates.
  • Over the next few years, this debt will reprice at higher interest rates.
• Higher debt costs will be a headwind for businesses and their hiring plans.

Wage Growth Decelerating

• Wages are growing faster than inflation which helps support consumer spending.
  • The Atlanta Fed tracks wage growth which it recently pegged at 5.2% (down from 6.75% in 2022).
  • This is above inflation and above consumer’s long-term inflation expectations (most recently 3.2%)
• But as the employment market softens, how long can this continue?

Credit Card Debt

• In the face of inflation, consumers continue to spend money. One of the ways they keep spending is by taking on more credit card debt.
• Outstanding credit card debt is at an all-time high of $1.08 trillion.
• Worse yet, this credit card debt is accumulating interest at a rate 25% above recent levels!
• In early 2022, $850 billion of credit card balances would accumulate interest at a rate of about $136 billion/year. 
• Now, $1,080 billion of credit card debt is growing by over $216 billion/year…. A 60% increase in debt servicing costs!

Things should be okay if the job market stays tight but how much more gas does the consumer have left in the tank?

The consumer still hasn’t fully experienced the “long and variable” impacts of monetary policy.